Lesson 2
The Collateral Engine
Watch MOVE as your collateral system health indicator. Low MOVE enables leverage expansion (bullish for risk assets). High MOVE forces deleveraging (bearish). A MOVE spike can create a liquidity crisis even if the Fed is accommodative.
📊 Indicators mentioned in this lesson (click for details):
Modern finance runs on collateral. Understanding the collateral system is understanding how liquidity actually works.
How the Collateral Engine Works:
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High-quality assets (Treasuries, MBS) serve as collateral. Banks and hedge funds pledge these assets to borrow cash.
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Collateral can be rehypothecated. The same Treasury bond might back 3-4 different loans simultaneously. This multiplies effective money supply.
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Collateral velocity matters. How many times does the same asset get used as collateral? High velocity = high effective liquidity.
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Repo markets facilitate this. Banks lend cash secured by collateral. Hedge funds borrow cash against their holdings. This is the plumbing of modern finance.
When the Engine Breaks:
- Collateral values fall (interest rates rise → bond prices fall)
- Margin calls hit (need more collateral or pay back loans)
- Fire sales begin (forced selling to meet margin calls)
- More collateral values fall (selling begets more selling)
- Liquidity freezes (no one wants to lend against falling collateral)
This doom loop is what happened in 2008 (MBS collateral), 2019 (repo crisis), 2020 (Treasury liquidity crisis), and 2022 (UK gilts).
The MOVE Index (MOVE) Connection:
When Treasury volatility is low, collateral values are stable, lenders are comfortable, and leverage expands. When MOVE spikes, collateral values become uncertain, lenders pull back, and the whole system deleverages.
This is why LOW MOVE = HIGH EFFECTIVE LIQUIDITY, regardless of Fed action.
Check your understanding
Lesson Quiz
Quiz Check
What is the credit multiplier effect?
Quiz Check
In March 2020, the Fed injected massive liquidity but markets kept falling for days. Why?